China s Emerging Mid-Market Where Good Enough Just Isn t

Transcription

1 Shanghai, 28 March 2012 Presentation to Stanford Alumni Club China s Emerging Mid-Market Where Good Enough Just Isn t Presentation by John Jullens - Director,, Greater China

2 It is no secret that the world s center of gravity is rapidly shifting back towards the East, and especially towards China 100% 95% 90% 85% 80% 75% 70% 65% 60% 55% 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% China s Share of Global GDP F, by PPP (constant 2005 international $) F2050F EIU, Nexis, World Bank, CEPII, Literature research,; analysis US: 10% China: 28% Western Europe: 7% Latin America: 7% Japan: 3% India: 12% All other countries: 34% China s Fall and Rise China enjoyed cultural and political supremacy for two millennia in the premodern world ( ) Advanced water management techniques Meritocratic imperial bureaucracy Confucian code of virtuous conduct Unchallenged military prowess Following the Great Divergence, China experienced almost 200 years of upheaval and chaos ( s) Chinese explanation: aggression, opium Western explanation: Industrial Revolution Other factors: Malthusian crisis, Manchu hubris, shortage of raw materials (e.g., wood), etc. China has re-emerged during the past thirty years (since 1980s) Selective regulatory liberalization (bidirectional) Progressive FDI levels and integration of China-based activities into MNCs global value chains 1

3 China s re-emergence will have important economic and geopolitical implications a smooth transition is unlikely Y2010-Y2020 Expected Growth Rate 12% 11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Transition Of Global Economy India Russia Brazil Japan China Western Europe We are in a time of transition - The economic world order that prevailed in the 1990s is being replaced by a different kind of global economy Peter Rodriguez (Darden) 12 US Y2010 GDP (Tn US $) Impact of China s Rise During the last thirty years, there has been a seismic shift in the global economy China and India, the two most populous nations on the planet, have rapidly emerged as Trade powerful issues economic forces Meanwhile, Geopolitical the issues U.S. experienced one of the worst periods of economic performance in its history during the first decade of the 21 st century Global energy market is violate and While unstable certainly impressive, China s rise will likely China s also energy create resources significant are limited economic and geopolitical tensions Environmental sustainability Competition for natural resources (e.g., oil, wood, rare earth metals, etc.) Incompatible political systems and economic development philosophies (i.e., Washington Consensus versus State Capitalism) Global Insight, CEPII, Literature research, analysis 2

4 Economically, China is already - or will soon become - the world s largest market for many consumer and industrial products China s Share of the Automotive Market NAFTA Growth thru 2020: 5,528K CAGR ( ):4% Western Europe Growth thru 2020: 1,527K CAGR ( ):1% Eastern Europe Growth thru 2020: 2,835K CAGR ( ): 6% Asia Pacific Growth thru 2020: 12,626K CAGR ( ): 5% Latin America Growth thru 2020: 2,899K CAGR ( ): 6% Africa/Middle East Growth thru 2020:1,264K CAGR ( ):4% = Area Reflects Size Of 2009 Actual PV Sales = Area Reflects Size Of 2020 Forecasted PV Sales Mobile Phones Beer Dairy Products Crude Steel Paper 833M Users (2010) Global #1 42B liters (2010 Production) Global #1 37.3M tonnes (2009 Production) Global #3 572M tonnes (2009 Production) Global #1 (46.7% of total production) 89.7M tonnes (2009 Production) Global #1 Global Insight Data, analysis 3

5 However, much of this growth will come from China s rapidly developing mid-market of Good Enough products Past Present / Future Premium Mining Equipment (Share in Value) ~30% Construction Equipment (Share in Value) ~5% Changing Shape Of Many Chinese Markets Historically, China s markets have typically been pyramid-shaped, characterized by a few high-end Western brands and a very large number of local Chinese brands, who offer cheap, low-quality products Premium Mid- Market Low-end Mid-Market Low-end ~40% ~30% ~80% ~15% However, many Chinese industries become diamond-shaped as they grow and develop Small segment of high-end products for discerning customers with significant purchasing power Dominant mid-market segment of products for a rapidly growing group of value-seeking customers Evolving base of lower quality products, designed to meet the basic needs of local customers with limited purchasing power analysis 4

6 This presents MNCs with a significant challenge, as completely different strategies are required to succeed in these mid-markets Automotive Industry Example Premium Segment Strategy Market Characteristics Slow growth rate Replacement demand Premium price point Mid-Market Segment Strategy Market Characteristics High growth rate First-time buyers Budget price point Consumer Profile High income High brand awareness Increased emphasis on non-functional product and service attributes Consumer Profile Low income Low brand awareness Primary emphasis on functional product and service attributes Strategic Imperatives Premium brand strategy and facilities Conquest sales to attract competitive make drivers Loyalty initiatives to retain existing buyers Upgrade HR and other capabilities Strategic Imperatives Value brand strategy and facilities New customer acquisition strategy Network expansion strategy Introduce basic HR and other capabilities Literature research, analysis 5

7 Not surprisingly, MNCs are often structurally disadvantaged relative to their local Chinese competitors Exceptional Complexity Continent-sized country Significant geographic diversity Hyper-competitive environment Fragmented distribution channels Absence of hard data and other information Language and cultural differences Unique Market Requirements Local product requirements and price points often prevent MNCs from simply decontenting their world-class products good enough just isn t As a result, MNCs must migrate major value chain activities to China (e.g., R&D, product development), while maintaining global scale and organizational coordination and efficiency Uneven Playing Field China employs a bifurcated strategy to meet its twin goals of complying with WTO commitments and retaining some control by complementing liberalization at the aggregate (macro) level with reregulation at the sectorial (micro) level Sector strategic value Unique sectorial characteristics analysis 6

8 Conversely, China is rapidly becoming the breeding ground for a new type of global category killer: Mid-Market Innovators Unique Factor Conditions The factors promoting mid-market innovators have never before been in place all at once China s immense market Hyper-competition Explosive growth in infrastructure investment Relatively protected market access Huge supply of cheap labor at all levels Etc. Mid-Market Innovators These unique factor conditions are creating a new type of competitor High technology at low cost Innovative and ambitious Variety at low cost Low-risk decision making Globalization Chinese mid-market innovators will find it much easier to expand globally than their Japanese and Korean predecessors in the past The earth has become much flatter No need to develop expertise along the entire value chain, due to modularization, outsourcing, off-shoring, etc. Globalization of the market for talent and other services (e.g., consulting) analysis 7

9 SANY is a typical example of a Chinese Mid-Market Innovator who is rapidly moving up the value curve and expanding globally Early Stage Domestic Player Start-up as a private company at Hunan province in 1989 Focused on offering budget-price products as substitutes to expensive imports Gained market share in the low/mid-end rapidly Rapid Growth in the Chinese Mid-Market Mainly organic growth R&D accounts for 5%- 7% revenue Rapid growth in China Developed strategy by monitoring Caterpillar and Komatsu in China Global Expansion Expansion in emerging markets and subsequently Europe in 2005 Half of sales are now estimated to be from Europe (~ 1.8bn in 2011) Acquisition of Germany s Putzmeister, the world s leading concrete machinery company Literature research, analysis 8

10 Many MNCs will find it difficult to overcome this challenge - especially smaller and medium-sized firms Client Example Background Leading privately-owned manufacturer of agricultural machinery Harvester Tractor Forage equipment High-end niche player Industry pioneer High quality/technology content Strong engineering capabilities China Imperative Core European market saturated China to become largest market in near future Key international competitors making major investments in China Strategic Challenges Need to localize products Design Assembly Supply base Distribution Lack of deep in-market know-how Regional demand variety Regulatory environment Partnership with local players IP protection Etc. Significant resource constraints Financial Managerial analysis 9

11 To defend their global positions, MNCs will have to consider four potential strategies they are not mutually exclusive 1 Stay at home Four Strategic Options for MNCs Option 1: Remain focused on upper tier and leave mid-market to other competitors 2 Wait it out Option 2: Wait for mid-market demand to catch up to premium demand 3 Win in China Option 3: Develop required products, capabilities, and other resources to compete proactively in the Chinese mid-market 4 If you can t beat em Option 4: Partner with one or more Chinese competitors and develop the (global) mid-market together analysis 10

12 Many MNCs have to resolve a classic prisoner s dilemma when trying to formulate their mid-market strategy in China High-speed Rail Example Siemens s Strategy Stay Away Play Comments Alstom s Strategy Stay Away Play Win in China (short-term?) Maintain Status Quo Lose China Maintain Status Quo Compete in China (short-term?) Lose China Compete in China (short-term? Win in China (short-term?) MNCs may face a prisoner s dilemma when deciding whether or not to play the game in China In most cases, playing may be the better choice, as at least one competitor is likely to do so Capture incremental profits Retain some control over the eventual outcome Develop new experiences and relationships in China Literature research, analysis 11

13 A few MNCs will have the strategic resources and/or capabilities to succeed globally without having to win in China s mid-market High-end brand with large legacy brand equity Irreplaceable Resources Cutting-edge and fast-evolving technology analysis 12

14 In other industries, MNCs may simply want to partner with their Chinese competitors and develop the (global) mid-market together Background Global fiberglass manufacturer, traditionally splitting the global market with 3-4 other large global companies Economies of scale important Chinese companies have emerged rapidly in the industry and started to export into not only other emerging markets, but also into developed markets (e.g., Australia) The top two global players (Owens Corning and Vetrotex) have decided to merge, in part due to the rapid growth of the Chinese companies Strategy Faced with a more concentrated high-end market and more competitive low-end market, PPG decided to set up a JV with Sinoma, a Chinese SoE A JV: CFO assigned by PPG and CEO assigned by Sinoma PPG keeps the proprietary technology to themselves to prevent Chinese competitors from entering high-end market (e.g., sizing agent) analysis 13

15 However, most MNCs will have no choice but to find a way to win in the Chinese mid-market Right to Win Capabilities Driven Strategy Imperatives to Win in Chinese Mid-Markets Adopt the right mindset Right to Win Develop competitive midmarket products Build and enable the local organization in China Try to level the playing field Integrate China with the global organization analysis 14

16 Adopting the right mindset is a critical first step for (too) many MNCs misaligned priorities and misconceptions remain common Misaligned Priorities b/w Headquarters and Managers in China, MNC (Difference b/w Respondents based in China and All Respondents, in % respondent) Headquarters Underestimates the Challenges 5 Headquarters Overestimates the Challenges Lack of available local talent Competition from domestic companies Lack of autonomy to make the right decisions for the Chin Risk of trade and economic disputes between China and oth Lack of IP protection Lack of legal protection in general Unpredictable nature of Chinese government Competition from other foreign companies EIU, analysis 15

17 Developing competitive mid-market products will require many MNCs to adopt a low price as opposed to a low cost approach Product Development Optimization in Low Price vs. Low Cost Car Product Strategy Concept Development Engineering Design Ideation Market Analysis Concept & Sketch Clay & Physical Models Surface Design Advanced Engineerin g Packagin g Structural Design Design Analysis & Verification Dimensioni ng & Tolerance Low Price Car Product ideation, market intelligence geared to identify sub 5K target segments Tailored to do early trade offs between product cost and value De-contenting the vehicle through calculated trade offs - value to cost Variable cost reduction through innovative bottoms up design Low Cost Car Product strategy function is not differentiated from other OEMs Tailored to do use existing platforms and architectures Component reduction through functionality increase etc Re-use of parts from the bin Rigorous use of standard off the shelf components analysis 16

18 MNCs must enable their local country organizations in China and start creating the first truly globally integrated firms The Multinational Firm (1970s 1980s) The Transitional Firm (1990s 2000s) The Globally Integrated Firm (Emerging) Global HQ Local Unit Local Unit Local Unit Local Unit Local Unit Global HQ Global HQ Local Unit Local Unit Local market strategic autonomy Uniform local subsidiaries Global headquarters Integration across market boundary Differentiated local subsidiaries Global headquarters Networking of markets, value activities, dispersed businesses Differentiated global business Multiple headquarters M.P. Koza et al., Strategic Management Society, analysis 17

19 MNCs should develop an explicit government relationship management strategy to try to level the playing field The real key decision makers Central Party School People s Liberation Army PARTY STRUCTURE Communist Party of China (CPC) General Secretary Hu Jintao Politburo Standing Comm. 9 Members - Meets Weekly Chairman Hu Jintao Politburo 25 Members - Meets Monthly Policy Research Unit Central Committee Members - Meets Annually SLGEF Central Military Commission Chairman Hu Jintao Organisatio n Department The National Party Congress, theoretically at the top of the pyramid, convenes once every five years to elect a Central Committee Decision s Proposals State Commissions GOVERNMENT STRUCTURE National People s Congress (NPC) Chairman Standing Comm. Wu Bangguo 3000 members, every 4-5yrs NPC President Hu Jintao NPC Vice President Xi Jinping State Council Premier Wen Jiabao + 4 Deputy Premiers Supreme People s Court Supreme People s Procuratorate Ministries NDRC SASAC GACC 21 Others MOFCOM MOT MOF Regional Provincial Party Committees 7-22 Members Bottom up Party Secretary Mayor State Bureaus Top Down Provincial Governments Municipal Governments Local Democratic Socialist Party Model CPC - 70 Members - Geographic / Factional Power Base Local People s Congress and other government related divisions Major Multinationals in Permitted Industries Townships Major Local Businesses Note: As of October 2007, the 17 th CPC National Congress 18

20 Finally, most MNCs will have to improve integration and place China at the core of their global strategies Win in China GMIO: The New GM Reverse Innovation Literature research; analysis 19

21 Summary A new category of competitors Chinese Mid-Market Innovators is beginning to change the competitive landscape around the world The established incumbent strategy - of trying to divide the market with just good enough products for the low end - will increasingly no longer work MNC, will have to choose among four - not mutually exclusive - strategies to respond effectively to the challenge from Chinese Mid-Market Innovators Stay at home Wait it out Win in China If you can t beat em 20

22 Contact Information John Jullens Director / Co-lead Engineered Products & Services practice Suite 2511, One Corporate Avenue No. 222 Hu Bin Road Shanghai , P.R. China Telephone: Fax: john.jullens@booz.com 21